Fitch has warned Britain it could lose its top AAA rating within the next few
years. But what are credit rating agencies and how do ratings work?

Credit rating agencies assess the risk of investing in governments and companies. Moody's, Standard & Poor's and Fitch Ratings are the agencies. They also provide financial data and information on bonds, equities and mutual funds.

What is a credit rating?

A credit rating is an opinion of the general creditworthiness of countries, companies and individuals. Lower credit ratings result in higher borrowing costs because the borrower is deemed to carry a higher risk of default. A downgrade for Britain would mean buyers of UK Government bonds would want to get paid more to compensate for the risk of holding the debt.

The use of rankings such as AAA or Baa1 is just the shorthand used by rating agencies to distinguish different ratings.

What are sovereign credit ratings?

Sovereign credit ratings measure the risk of investing in countries – political as well as economic risk. For instance, Standard & Poor's lowered its AAA credit rating for the US government last year partly because talks on a deal to raise the borrowing limit "took too long" and were "at times too divisive".

How do credit rating agencies make money?

Agencies typically receive payment for their services either from the borrower that requests the rating or from subscribers who receive the published ratings and related credit reports.

How much weight does a rating carry?

A lot of investment, such as corporate and government bonds, must carry a credit rating. This has resulted in credit rating agencies becoming very influential. However, their role in the sub-prime crisis, when they rated various mortgage-backed financial instruments that have subsequently been branded "toxic", has damaged their reputation and government's are looking into their role.

What does a negative outlook mean?

A negative outlook - like the one Fitch has placed on Britain - does not necessarily precede a rating change. However, it is generally considered to be the first step towards a downgrade. As George Osborne's has previously put it, the move is a "reality check".

How does Fitch rank its debt?

Fitch uses an ABC rating for long-term debt and a F rating for short-term debt. This is how its long-term debt is ranked:

AAA (xxx)

‘AAA’ National Ratings denote the highest rating assigned by the agency in its National Rating scale for that country. This rating is assigned to issuers or obligations with the lowest expectation of default risk relative to all other issuers or obligations in the same country.

AA (xxx)

‘AA’ National Ratings denote expectations of very low default risk relative to other issuers or obligations in the same country. The default risk inherent differs only slightly from that of the country’s highest rated issuers or obligations.

A (xxx)

‘A’ National Ratings denote expectations of low default risk relative to other issuers or obligations in the same country. However, changes in circumstances or economic conditions may affect the capacity for timely repayment to a greater degree than is the case for financial commitments denoted by a higher rated category.

BBB (xxx)

‘BBB’ National Ratings denote a moderate default risk relative to other issuers or obligations in the same country. However, changes in circumstances or economic conditions are more likely to affect the capacity for timely repayment than is the case for financial commitments denoted by a higher rated category.

BB (xxx)

‘BB’ National Ratings denote an elevated default risk relative to other issuers or obligations in the same country. Within the context of the country, payment is uncertain to some degree and capacity for timely repayment remains more vulnerable to adverse economic change over time.

B (xxx)

‘B’ National Ratings denote a significantly elevated default risk relative to other issuers or obligations in the same country. Financial commitments are currently being met but a limited margin of safety remains and capacity for continued timely payments is contingent upon a sustained, favorable business and economic environment. For individual obligations, this rating may indicate distressed or defaulted obligations with potential for extremely high recoveries.

CCC (xxx)

‘CCC’ National Ratings denote that default is a real possibility. Capacity for meeting financial commitments is solely reliant upon sustained, favorable business or economic conditions.

CC (xxx)

‘CC’ National Ratings denote that default of some kind appears probable.

C (xxx)

‘C’ National Ratings denote that default is imminent.

RD (xxx): Restricted default

‘RD’ ratings indicate an issuer that in Fitch Ratings’ opinion has experienced an uncured payment default on a bond, loan or other material financial obligation but which has not entered into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure, and which has not otherwise ceased business. This would include:

a) the selective payment default on a specific class or currency of debt;

b) the uncured expiry of any applicable grace period, cure period or default forbearance period following a payment default on a bank loan, capital markets security or other material financial obligation;

c) the extension of multiple waivers or forbearance periods upon a payment default on one or more material financial obligations, either in series or in parallel; or

d) execution of a distressed debt exchange on one or more material financial obligations.

D (xxx)

‘D’ National Ratings denote an issuer or instrument that is currently in default.